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Proper Audits, Controls Critical in Identifying Payroll’s Bigger Problems

BY: Carney Kim, CPP | 06/27/22

In a perfect world, payroll would be fully automated and error-free 100% of the time and companies would never have to worry about payroll fraud or regulatory compliance. Unfortunately, this is not the case for most of us. Even the most tech-reliant payroll solutions still require some degree of human input. And, as we all know, humans aren't perfect and errors or mistakes will be made.

We all know that payroll is a critical piece of every business, and payroll errors can have serious impacts to employees and the company. Something as trivial as a minor typo or a missed step during a routine update to an employee profile that goes unnoticed for even a single pay period might take days, weeks, or even months to resolve. Regardless of whether these errors are intentional, they could result in costly penalties and lead to an audit from an external agency. If the errors impacted reporting or tax filings, the business may be required to file amendments and issue corrected forms to the appropriate parties. And let's face it, nobody wants to issue a Form W-2c, Corrected Wage and Tax Statement. To minimize the likelihood of this happening, it's important for payroll departments to conduct periodic audits of their work and have the appropriate controls in place.

When Internal Audits Should Be Done

Internal audits can and should happen at regular intervals to ensure payroll data is clean and accurate. The timing and frequency of audits could vary from company to company, depending on several factors. Some organizations might have audit processes built into every single payroll. Others might choose to audit items monthly or quarterly. In many cases, a business might choose to perform quick audits on every payroll and more comprehensive checks on a monthly or quarterly basis.

A regular audit might be as simple as spot-checking a few employees' records during each payroll processing period to ensure the payroll calculations are correct. Some common items to look for might include accidental payments to inactive employees, excessive overtime, and holiday hours being paid for periods that don't include holidays. It's also a good idea to keep an eye out for recent employee changes which have impacts on employee pay, such as pay increases, changes to tax or benefit elections, and new hires or recent terminations. Many modern payroll solutions offer tools that make it easy for a payroll processor to identify and address issues while working on the payroll. For payrolls that don't have too much fluctuation from one period to the next, comparing the current run to a previous period could be a quick and easy way to spot any anomalies.

Regular Audits Help Uncover Problems

These regular audits can also be helpful for uncovering larger problems. For example, the payroll processor may find that the consistently high number of overtime hours being reported for a specific team or department is, in fact, valid. However, the excessive overtime may be indicative of the department's need for more resources or other issues that may be causing employees to be overworked and burnt out. For payroll teams that are integrated or work closely with HR, this can provide valuable insight into areas of the company that might need some extra attention.

Audits conducted monthly or quarterly could be used to verify that your payroll data to date is reasonable, that tax calculations and other items such as retirement deductions are treated properly, and the appropriate limits are being applied. If the regular audits for each pay period for the quarter have been clean, the quarter-to-date information should, in theory, also be clean and error-free. Likewise, if each quarter's data is clean, the annual data should be, too. When payroll performs regular audits, discrepancies can be spotted and addressed; no more scrambling during year-end to fix something that happened at the beginning of the year.

Having the appropriate internal system controls is another important piece in reducing errors as well as preventing misuse of the payroll system and the highly sensitive data it contains. Many payroll systems can be configured to assign different roles and access to different users. In doing so, an organization can limit the information that can be viewed or edited and ensure the only people who have access are the ones who need it to perform the duties of their jobs.

Some platforms might also have the capability for workflows and different levels of approval to be built in, so certain actions such as changes to pay rates and other data can be made to require additional approvals before going into effect. Some organizations might have separate “payroll approver” roles that only have access to view and transmit payroll, with processor roles set up to allow editing of payroll data. Most payroll systems also keep audit trails of any system changes which can be an effective way to prevent system abuse and payroll fraud.

Of course, multiple levels of security and workflows designed to go through several approvals may not be practical for all organizations. It may not be worthwhile for smaller businesses to have multiple access levels or may not have (or need) a payroll solution that allows for that level of customization. Other companies might have a heavier reliance on paper records and physical files. Internal controls are still important to ensure that records are not tampered with and employees' private information is kept confidential. A system of dual controls can be put in place to prevent unauthorized access to sensitive information.

There isn’t a one-size-fits-all solution for internal audits and controls that will work for everyone. The needs of each business may differ and will depend on several factors. The important thing is to find and to implement a process that works and makes sense for the organization. A good system of audits and controls will allow the payroll team to process accurate payrolls and error-free filings and reports, all while keeping compliance, maintaining data integrity, and protecting employees' confidential information. If your company's current controls or audits need an overhaul, your local APA chapter can be a great resource to help understand best practices and gain some insight into what other organizations might be doing.

Carney Kim, CPP, is a principal consultant. He is a member of the APA’s Best Practices and Small Employers’ Best Practices Subcommittees of the Strategic Payroll Leadership Task Force (SPLTF), the Hotline Referral Service, and the Board of Contributing Writers for PAYTECH. He is also a member of the Hawaii Chapter of the APA.